Savings and Investment Manual

Deeply discounted securities: meaning of deeply discounted security

The general rule

ITTOIA05/S430 explains the meaning of ‘deeply discounted security’ (DDS). It is a security where the amount payable on maturity, or any other occasion when the security can be redeemed will or may exceed the issue price by more than 0.5% for each year in the redemption period, up to a maximum of 30 years. The redemption period is the period between the date of issue and the date of redemption. In effect the amount is the lower of

0.5% of the redemption amount for each year of the bond’s original maturity, or

15% of the amount payable on redemption.

Where securities have an original issue maturity of less than one year, the 0.5% per annum figure is reduced pro rata.

Any interest payable on an occasion of redemption, for example where the final coupon date coincides with the maturity date of the security, is ignored in performing the calculation.

The test for deep discount is carried out in the currency of issue.

Example 1

Company A issues securities for £1,000 which are redeemable in 10 years time for the subscription amount increased by the percentage movement in the Retail Price Index over the same period. As the linkage to the RPI may give more than a 5% increase in value (10 years x 0.5%) over that period, the securities are deeply discounted securities.

Example 2

Company B issues a 12-month security for £950. It is redeemable for £950 at maturity or, depending on events, for £1,000 after 6 months. The occasion of early redemption is not disregarded under ITTOIA05/S431 (SAIM3030). The difference between the issue and early redemption prices is more than £2.50 (£1,000 x 0.5% x 6/12). The security is therefore a DDS.

Example 3

Bank C issues a 5-year security that is linked to the FTSE 100 share index. Each security has a nominal value to £100. If the index rises, the investor receives on redemption £100 multiplied by the percentage rise in the index. For example, the index has risen to 150% of its starting value, the investor receives £150. If the index falls, the investor is guaranteed to receive back his or her £100, so the security is not an excluded indexed security (SAIM3050). Since the security may give more than a 2.5% increase in value over the period (5 years x 0.5%), it is a DDS, even though there is no certainty as to the redemption amount.